US Macroeconomic Performance in 2018, and Whether to Be More Concerned with the Trade or Budget Deficit

Answer

Part (a)

Macroeconomic performance is judged against the standard indicators — growth, inflation, unemployment and the external balance — and on three of these the US performed well in 2018.

Real GDP growth. Positive real growth of 3.2% means national income rose in real terms versus 2017 — actual growth, moving the economy nearer productive efficiency through fuller resource use. The rise reflects strengthening AD components: buoyant investment signals investor confidence in long-term prospects (a cause), while the resulting rise in factor incomes lifts purchasing power and material standard of living (a consequence).

Inflation. At 2.4%, inflation is low and prices broadly stable — the basket cost rose only marginally. Stable prices preserve the internal value of money (protecting the low-income and those on fixed incomes) and maintain export price competitiveness relative to higher-inflation economies (a consequence supporting next year’s growth).

Unemployment. At 3.9%, unemployment is low — close to the natural rate. A high proportion of the labour force is employed, minimising the output forgone from idle resources, and the strong derived demand for labour signals robust fundamentals. Low unemployment also raises tax revenue and cuts benefit spending, strengthening the fiscal position (a consequence).

The trade balance at −2.3% of GDP is a small deficit; while a surplus is preferable, a modest deficit may reflect imports of capital goods for process and product innovation, which can be reversed as the innovation raises future export revenue. On three of four indicators, then, the US performed well in 2018.

Part (b)

The US is a large, less open economy: domestic consumption and investment dwarf net exports, and it is relatively self-sufficient in resources. The thesis is that, given this nature, the US should be more concerned with the budget deficit than the trade deficit — the trade deficit’s effects are damped by the economy’s low openness, whereas the budget deficit’s sheer size cripples the fiscal space the US needs for future stabilisation.

Case for concern over the trade deficit. A trade deficit is worrying on three counts. As a cause, it may signal worsening export competitiveness — US brands losing ground to cheaper, better Chinese rivals (Huawei, Xiaomi vs Apple) — which, unaddressed, widens the deficit over time. As a consequence, the negative net-export term lowers AD and, through the reverse multiplier, produces a magnified fall in national income, raising demand-deficient unemployment and risking deflation. A persistent deficit also pressures the US$ to depreciate, raising imported input costs and generating cost-push inflation, and may deter FDI if investors expect further depreciation. But — decisively — these effects are muted because the US is large and less open, so $(X-M)$ is a small share of AD; the contractionary impact is limited.

Case for concern over the budget deficit. A budget (fiscal) deficit need not be worrying if it funds supply-side investment — infrastructure, capital goods, education — since the resulting productivity and incomes raise future tax revenue, making the deficit self-correcting. It is worrying, however, if it funds current consumption (welfare, defence) that raises no future productivity or revenue. More seriously, the deficit here is very large relative to GDP, which cripples fiscal capacity: facing a recession (as in the COVID fallout), the government can barely run an expansionary fiscal stimulus without further borrowing, and borrowing on this scale drives up interest rates, crowding out private consumption and investment and blunting the stimulus. The alternative — short-run austerity (lower G, higher T) to rebuild fiscal space — itself contracts the economy via the reverse multiplier, worsening hardship.

Judgement. The US government should be more concerned with the budget deficit. The decisive consideration is the nature of the economy read against the magnitude of each deficit. Because the US is large and relatively closed, the trade deficit’s contractionary and exchange-rate effects are damped and, at −2.3% of GDP, it is small and plausibly innovation-driven, so it is the lesser worry — and may even self-correct as innovation revives export competitiveness. The budget deficit, by contrast, is large, and its danger is not the deficit per se but the loss of fiscal space it implies: it leaves the US without the room to deploy expansionary fiscal policy when a downturn strikes, forcing either crowding-out borrowing or contractionary austerity. Since the ability to stabilise the economy in a crisis is more valuable to a large domestic-demand-driven economy than a modest external imbalance, the budget deficit is the greater concern — though the verdict would shift towards the trade deficit if its underlying cause were a structural and worsening loss of competitiveness rather than transient capital-goods imports.